Accounting in the cloud: Xero

Steve Vamos is the CEO of Xero — the cloud computing accounting software business. Steve took over from Rod Drury, the Founder of Xero, in April this year as CEO. 

In the interview we learn a bit about Steve’s background who has an interesting and diverse strong technology background and we learn what he is doing with the business and what his plans are.

Xero is a fascinating story; it’s been a huge success; people have made a lot of money out of Xero and the shares have come down a fair bit. It was capitalised for a little while at $7 billion, that’s now down to $5 billion capitalisation having fallen during the October correction along with all the other companies, particularly high-priced technology ones like Xero. 

Obviously, this business is going to be around a long time, as to whether it’s well-priced or not who knows but it’s certainly growing very quickly.  The subscribers increased by 380,000 to 1.6 million in the latest half year and so it’s certainly growing fast.

ASX code: XRO
Share price: $41.255
Market cap: 5.765 billion

Here’s Steve Vamos, the CEO of Xero.


Steve, you took over CEO of Xero in April.  Just remind us of your background, you ran Microsoft in Australia, I think, for quite a while and you’re a non-executive of Telstra.  Your CV talks about Apple and a few other things as well.

Yeah, my background is tech industry and my career started at IBM and then went to Apple where I ran Apple’s business in Australia and then Asia Pacific.  Then to Nine MSN where I was CEO of the Packer Microsoft joint venture when it was kicked off around 1998.  Then I worked through the early days of online advertising, then went to Microsoft and ran a big part of their international online business and then came back to Australia and did quite a bit of non-executive director work, advisory work across a whole range of different industries.

To be honest I thought you were going to be a non-executive director full time, that was going to be your job, because you picked up quite a few good boards and I thought there you go, and in fact there you are, you’re running a business again.  Not just any business, it’s a big one.

Over the last few years I developed, in a sense, a practice in working with CEOs of fast moving and changing businesses and was really fortunate a couple of years ago to connect with Rod and have a chat.  He was talking to me about his plans and his aspirations for Xero and asked if I’d help him out with a few of the elements of the business that really related to that growth on a global scale.  We started working together and after 18 months of working together the transition took place where he handed over the reins to me.

Yes, indeed.  What was the brief, was there anything specific?  Just to keep growing it or was there a specific thing that they wanted, that Rod and the rest of the board wanted you to do?

I think Rod and I, first of all, were really aligned around the potential and the purpose of Xero, just commitment and conviction to helping small business and helping small business grow was something I certainly related to.  The culture of Xero was something that was very much at home for me and I think that Rod could see that, and I think that also was a key factor in him handing over to me.  I think fundamentally when you look at the work the CEO of a global technology business has to do a lot of it is about turning strategy into action at every level of the company, it’s about evolving your product organisations for the obvious increase in complexity that comes with growth and scale.  Then also working out how do you build the right operating model so that you get the best out of all your efforts in different markets around the world that have their own differences and unique attributes whilst maintain the scale and focus you need as a global business.

With the experience I had Rod looked at that and said that’s not the work I want to be doing, you should do that work.  He obviously is still very much an innovator and a visionary, and he has great thoughts that certainly I listen to.  We work very well together with me I guess running the business and him having the opportunity to influence as a non-executive director.

Obviously, Xero is reasonably famous for becoming a $7 billion company in Australia without making a profit and I just wonder whether there was a timeframe now for you to do that.  I actually was looking at the cash, the September 30 cash flow statement, and if I take out Hub Doc, the $30 million acquisition of Hub Doc, it looks to me like you were actually, in an operational sense, cash flow positive.  Is that right?

The best way to reflect on it is really to sort of be consistent with the outlook and the fact that we are managing the business to cash flow breakeven within the current cash balance without drawing on any of our debt facility.  You’re right, in the underlying numbers that we saw in the half we’re definitely making progress towards that and you could say it’s nearer rather than further out.

Your net cash flow from operating activity was $36 million roughly. 

That’s right, and that was an improvement of $20 million YOY.

Yeah, but the only thing I would take off that would be the capitalised development cost of $33 million because the rest of it was kind of not operational so I just looked at them and thought they’re $2 or $3 million in the black.

Must be getting close, it is getting close.  I think there’s some numbers in the margin there related to acquisitions but I think we certainly haven’t declared that milestone at this point but we know it’s not far off.

You’ve raised $300 million from a convertible note and in the literature around that you’ve said it’s to do with acquisitions.  Can you tell us what the idea is with the acquisitions and perhaps start with Hub Doc, what was that about?

Yeah, so Hub Doc really ticked three important boxes for us and they align with our operating priorities, if you like, that come from the strategy.  The first is we operate in a global market that is still under-penetrated and so for us number one is to continue to drive the adoption of cloud accounting.  One of the interesting things is that New Zealand, where Xero was born, and in Australia obviously a market very close to home, the penetration of cloud accounting is in the 40s, 40% to 50% of businesses are now using a cloud accounting solution.  If you go to the US and other markets around the world it’s usually under 20%.  Number one is drive growth of that cloud accounting solution which is really about making it even more obvious to businesses, to accountants and book keepers why transforming their practice or why adopting cloud accounting is such an efficiency driver. 

The second element is to build the platform.  What we mean by that is once you’ve got accounts and book keepers and small businesses on the Xero platform there’s a broad range of new applications that you can provide to them that means that they start doing business on the Xero platform more so than recording business on the Xero platform.  That’s applications like projects, expenses, payroll and the bank fees.  The second element is about having more applications that drive people to do more on Xero.  Then the final one is really about building capability, technology, people, process, in different markets around the world.  Hub Doc ticked all three boxes.  Hub Doc enhances Xero’s cloud accounting solution by improving the efficiency of work flows. 

Hub Doc also has features which extract data from financial services and suppliers to small business so that extends Xero as a platform or a network and Hub Doc also gave us a great footprint in Toronto.  Canada is a great market opportunity for us and the people and the talent we acquired in Hub Doc as well as the technology are really on the road map that we have.  It really ticked all three boxes and that’s what we’re looking for, acquisitions that really enhance those three elements of our business.

Hub Doc looks a bit like a halfway house to Xero, it just extracts the information from receipts and invoices, it doesn’t take the next step.  This is superficial looking at it, it doesn’t take the next step, what you do, which is to pull that all together into financial statements and link with the bank.

You actually articulate it pretty well.  It is all about that, it’s about getting the data into Xero more efficiently, extracting the data more efficiently and then what they also have is they do have some elements to the workflows that integrate into Xero that make the whole workload and the process for accounts and book keepers much more efficient.  It sits on top of our accounting solution, our general ledger.

Are there any other similar acquisitions?  I noticed you’re doing some stuff in the UK, you seem to be focussing on the UK, is that correct or are you focussing as much on North America?

We’re focussing on a number of markets internationally.  We entered the Canadian market, we’ve also recently entered Singapore, Hong Kong and South Africa so the UK is important to us because the UK is growing extraordinarily well at 45% year on year in constant currency, actually higher growth rates when we look at local currency.  The UK is a really important market for us and that’s why we did announce the acquisition of a company called Instafile which again drives efficiencies for accounts and book keepers because it allows them to file tax returns from the Xero platform so it again frees up time.  By the way, that capability to submit tax returns out of Xero has been available in Australia and New Zealand, and has been shown to really help in the growth of our business because of the value it provides our customers.

That thing you said about operating to cash flow break even within existing cash reserves, that’s sort of a mantra for you, right?

Yeah, that’s a very important foundation.  In a sense obviously we see ourselves with everything I’ve just said to you there’s tremendous growth opportunities for us and we ought to be able to demonstrate that reinvesting or investing pre-cash or cash we generate back in the business is good for our shareholders and good for our business.  For that reason we’re sort of continuing to talk about the fact that as we achieve operating cash flow break even and exceed that we’d be reinvesting.

You increased subscribers by 380,000 to 1.6 million in the latest period which is obviously phenomenal growth.  Is there a sign at this point, now we’re in November, of the growth slowing down or is it continuing at that rate?

I can’t say too much about our performance outside of obviously the reporting period other than to say our expectation and our ambition is for continued growth at the rates you’ve seen.  We see there being tremendous opportunities around the world and we definitely have a growth mindset around that.

Okay, fair enough.  You also increased average revenue per user by 6%, obviously not as big an increase, to just over $31.  I’m just wondering is there much growth left in ARPU do you think, is that something that you can continue to grow?

6% ARPU growth, we’re pretty happy with that, but there definitely is tremendous opportunity.  That goes to really the second of those three priorities I mentioned around building out Xero as a platform from which business can do what it does, not just record what it does.  At this stage we’re still early days because we launched a couple of our products, projects and expenses really only about six months ago.  We’re building a capability in our business to do that, to sell more to our existing customers.  Xero has really been focussed on adding subscribers of our base accounting solutions and now what we’re doing is we’re also providing more to those existing customers, that’s a capability we’re building.

On top of that you look at potential for transaction revenues, for example in financial services, payments allowing our customers to make payments and be paid on the platform, lending to provide partnerships which allow businesses a better pathway to being funded or acquiring funding.  Those are real opportunities for us as well so I’d say we’re just as ambitious about ARPU growth as we are on growing our subscriptions.

Who is your main competitor globally?

We have different competitors with different strengths in different market places.  It’s interesting, obviously everyone talks about competition and we certainly look at our competitors with a very respectful eye because my experience is probably two things.  One is that in the actual experience of a go to market environment in a new market, a developing market, your competition can be as much a friend as your foe because you’re really trying to drive awareness for and engagement with people to change, change how they do things and do something differently.  Competition is a good thing.  You go back to the early days of digital media and when I was at Nine MSN we actually collaborated with Fairfax to go out on the road together to promote online advertising because there was such a resistance to embracing it back then.  Our competitors in a sense help us because we’re all out there promoting a better place.

That said, where you see your competitors doing things that you’re not doing at the end of the day it comes back to you and how you respond.  I always say that you’ve got to get your own game right much more so than worry too much about what the competitors are doing day to day but we’ve got good competition around the world and we respect them, learn from them, but it’s really about making sure Xero is the best it can be.

Is Quicken the biggest one?

In the US no question that Intuit have a strong position in the desktop but when it comes to cloud accounting it’s still early days in the US and we have a strong belief that we can build a good business in the US. 

Yes, and obviously it’s a different story here.  As you say there’s 40% penetration of cloud computing here and MYOB is further down the track than Intuit is in the US I guess you’d have to say.

It’s interesting, I’m not sure that it’s for me to compare but MYOB definitely innovated with desktop accounting and I think you’d say Xero has done the same in cloud accounting, we’ve been disruptors in cloud accounting and the penetration rates of cloud accounting in Australia and New Zealand are testament to Xero’s innovation.

I suppose the reason I’m asking about competitors is really to wind my way towards the question of do you think it is ever going to be worthwhile for you to acquire one of your competitors?

That would be just speculating and I think the challenge in the technology industry is that the issues with legacy are such that you’re really better to stick to your own game and drive organic growth or adjacent growth rather than going down that path.

That’s really the purpose of the question in a way because I thought that would probably be the case because a lot of your competitors are coming off desktop solutions and trying to find their way to cloud whereas you’re a cloud native.

Yeah, and so for us if you look at our platform, which I mentioned before, we have 700 companies building applications that connect to Xero and so we’ve created this environment or ecosystem that is innovating all the time and beyond that there are a hold range of new things coming as well.  When we look at the acquisition focus for us as we go forward it’d really be more oriented towards extending the functionality and reach of Xero as a cloud accounting platform but also really taking advantage of the fact that we have this vibrant ecosystem and there are opportunities there for us to partner with those organisations more deeply as we have with Gusto in the US for payroll and from time to time to acquire organisations that really add value to what Xero has and extends what Xero has like Hub Doc.  To my mind those are the things in the frame much more so than anything else.

That’s what I would have thought.  I think that’s pretty clear, I mean the business is growing pretty quickly, about to hit, if not already hit, cash flow break-even.  Do you think that before you’ve finished being CEO the company will start paying dividends?

I would hope not and the reason I say that is that when you look at some of the metrics, we call them SAS business fundamentals, software as a service business fundamentals.  One of the metrics that we use is lifetime value to cost of acquisition, our lifetime value, the ratios are such that depending on which way you look at it every dollar wee invest gets you around $6 or $7 back.  I would hope that for a long time we can demonstrate to ourselves and our shareholders that investing back in Xero and allowing it to continue to grow fast is by far the best use of our money.

Sounds very Warren Buffet-esque.

Well, where Xero sits today is really at the forefront of another one of these shifts that you’ve seen and I’ve seen over the years where technology transforms industries.

Great to talk to you, Steve, I look forward to talking regularly in the years ahead.

Thanks, Alan, good to talk to you too.

That was Steve Vamos, the CEO of Xero.